01/02/14

From Comment

Due Diligence: Cash and Remediation

Burke Files highlights the need to consider that not all clients come from traditional western economies and examines the necessity of due diligence in investigating the origin of funds from such locations.

The Bahamian Company as a Trus…

There is a saying on a poster in our office “Come the revolution things will be different, no better just different;” no doubt one of the more optimistic sayings from Murphy the philosopher and his book of laws.

In the developed world, revolutions and severe civil unrest are rare. Oh sure, you get a night, every so often, filled with looting and car burning when a certain basketball or soccer team wins a championship - but that is about it. Baseball and cricket fans are so much more reserved.

Now imagine this as a daily occurrence, not just for a few days, but week after week. The fabric of society and civility slowly rends and coalesces into groups of common backgrounds, be it tribes, religions, ethic origins, it matters not as groups form for communal defense and survival. Concurrently, the police are unable to enforce even the most basic of the remaining laws and the police withdraw to the safety of their stations, or just desert and go home. Simple utility services become sporadic and fail. No water, no electricity and no refuse pick up follows the failure of law.

Vacuums form and are filled by those who seek power, profit, and people fill these vacuums either purposefully or because others push them to do so as they are good at wielding power or making profits and can protect and support their group.

In much of the fringes of the developing and reorganising world such as post colonial, post revolution in Africa, - post Soviet, post dictator in Central Asia, and post banana republic, post idiot squirrely dictator in Latin America - distrust in past governments is hard wired and trust in current governments and its governmental institutions is, well, iffy. Current unrest could be still just around the corner. To these citizens neighbourhood buildings pock marked by bullets serve as a tangible reminder of what was, and could be again.

Specifically the citizens and businesses, as the businesses are made up of the citizens, do not trust what the government will do with or to the financial institutions if, or when, severe civil unrest or revolution occurs. The more corrupt a current government (mixed with the inevitable dash of incompetence), the increased distrust citizens have in it. The greater the distrust the more likely the banks are not to be used for anything other than target practice. Inevitably, the last act of a failing state is to publicly blame the western bourgeois subversive running dog capitalists and their intelligence networks for the country’s failings. Privately they grab the banks and the cash so the, soon to be exiled, leaders can do their own empirical research on what it really is like to be a bourgeois running dog capitalist.

What does happen in these failing and failed state circumstances is that a great deal of flight capital is generated and it seeks a safe home. The safe home domiciles of choice, since the end of World War II, have been Western Europe and North America. Also, much of the flight capital is often physical currency. While no one gave a second thought about physical currency a few decades ago, the advent and convenience of digital currency has made physical currency a bit of an outlier for us in Western Europe and North America. We think of physical currency as a way to avoid tracking transactions as used by those in the underground economy or selling drugs. While it may indeed be that, these places have no digital currency or functioning banking systems. There is no ‘other choice’ of exchange except barter. Hard currency is what was used to survive as the banks ceased functioning in these countries, as what money was left in the banks was either blocked, restricted on daily withdrawals, or the banks were shuttered and seized.

Libya - banks closed in January of 2013 and have not reopened. People are transporting cash in roll about luggage.

Georgia - had a tiff with Russia and lost both territory and the ability to work through Russian banks for quite some time. It became an all cash economy.

Venezuela - a spiral down the path of forfeiture, seizure, restrictions, and on the way to a full revolution.

Argentina - defaulted on debt obligations, seized all pension funds, restricts both imports and exports through currency controls. As one immigrant told me - he would rather have painful boils than an account in an Argentine bank account. The difference, as he continued was eventually the boils will heal.

Syria - full revolution, all society and economic infrastructure has collapsed.

Kazakhstan - has ongoing internal battles with bankers where many bankers have been arrested.

Ecuador - seized and nationalised most banks and media outlets and froze some company accounts as well as jailed many bankers and business owners.

Zimbabwe - took a country 45 years backward in economic development, and is surviving on mineral extraction for what revenue it can earn.

Angola - a postcolonial robber baron junta…

Russia - “see Zimbabwe”

The physical flight capital is flowing out of these places, as well as others, and seeking redeployment.

So what are we as professionals to do for due diligence on this cash? As the cash has no physical trail, we need to work to reconstruct the trail. The first step is a comprehensive background on the beneficial owners. This is not just a database and a ‘find newspaper story’ job. This is real work with real investigators who can get the full information on what happened. Ideally, the client with the flight capital is helpful and open with some of the research; however, they may not be quite as open as one might think. Many of these places are still volatile and knowledge of a person’s accumulated wealth will make them and their families a target for mischief, such as kidnapping. Thus, not only does the research need to be thorough, it must also be very discrete.

The second process is a good, documented as best as possible, narrative on how the funds were made. When a country devolves into chaos - there is a lot of money to be made, even just supplying basic necessities such as water, food, fuel, and security. Some call it war profiteering, but during these times many often supply valuable services once supplied or underwritten by the former failed state. The persons often provide these services at significant physical and fiscal risk. Others profit through the privatisation of state enterprises. Now to us, many years in the future, it looks like the proverbial ‘shooting fish in a barrel’ type investment, but many more of the state industries that were privatised failed than succeeded. Many investors and funds from the west were not willing to work in countries where the rule of law was suspect, if even present. Thus, the profits go to those who chose to take the risks. This is appropriate.

Once the histories of the people, endeavours and the cash are documented - it will be time to begin the process of remediation of the cash into the modern banking system. Full disclosure to a given bank must be made in advance. The bank should pre-approve the client and the funds before anything else is done. For your client you must use mature and reputable banks, not small or dodgy institutions. Moving the funds in one move is unadvisable. It sets up a concentration of risk that is always unwise. The risks are loss in transit, bank failure, bank banking out of acceptance, etc… While most of the risks are insurable, it can take years to recover from an insurance company. Thus, it is wise to both insure and break up the remediation of the cash in to a stepped process.

We must be realists and understand there are worlds and economies in which our clients have lived and prospered that are certainly not a traditional western economy. We must also be certain that the funds do not have either criminal or sanctioned party origins. If the prospective client has any judgments or obligations it is wise to set a portion of the funds aside in an escrow or trust to settle those obligations concurrent with remediation of the cash.

Remember - in all things be diligent - especially in your due diligence.

About the Author

L. Burke Files DDP CACM, PresidentMr. Files is an international financial investigator and due diligence expert who has run cases in over 130 countries and has visited over 100 countries.
Mr. Files has tackled investigations running from a few hundred thousands dollars to over 20 billion. Along the way he became familiar with the knowledge of what people need to do, for due diligence, preventing corruption, and to avoid helping criminals launder money. He brings this experience of hands on investigating and problem solving experience to his lectures on Due Diligence, AML, and Anti-Corruption.
Prior to founding FE&E, Inc. he served as the Director of Corporate Finance for American National an investment bank focused on development stage venture capital. He was also employed by Oppenheimer/Rouse as a commodities specialist trading customer accounts in Agri-Business and 24-hour gold, silver, and foreign currency trading.
Mr. Files has authored six books, and many white papers and articles. He has been quoted in major publications including The Guardian, The Financial Times, Forbes, US Newsweek and more. He is the author of the award wining book Due Diligence For The Financial Professional 2nd Edition. Mr. Files serves on the board of directors for several private companies, funds, and non-profits.
Mr. Files active in several civic organizations. In the past Mr. Files has served as a member of the Arizona Governor’s Board on Solid Waste Management, as an advisor to the Governor’s Board on Economic Planning and Development. Mr. Files has also received a Commission and a Medal of Merit from the President of the United States.